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Many regional banks' second-quarter earnings might have fallen short of the Street's estimates, but results contradicted the extreme bear case that weighed heavily on the institutions' stock prices during the spring, according to Terry McEvoy, managing director at Stephens Inc.
In the latest Street Talk podcast recorded July 24, McEvoy discussed the key takeaways from the first week of regional bank earnings, including what results tell the investment community about banks' liquidity, credit quality and valuations.
The veteran analyst noted that close to half of the 100 largest banks had reported second-quarter earnings through July 24. He said 28% of institutions had fallen short of estimates for pre-provision. net revenue, while one-third of banks missed estimates for earnings per share. The analyst said earnings misses stemmed from weaker-than-expected net interest income and ongoing pressures on net interest margins as customers continued to shift funds out of noninterest-bearing deposits and into higher-cost interest-bearing deposits.
Still, McEvoy noted that there were positive takeaways from second-quarter results, which demonstrated that the most bearish fears in the marketplace over bank liquidity and credit quality appeared to have been overblown.
"I think what we learned is not every deposit relationship is going to JPMorgan or the too-big-to-fail banks. Not every office [commercial real estate] loan is going to go to 0," McEvoy said in the episode.
Through the first six months of 2023, regional bank stocks had fallen more than 30% as investors feared liquidity pressures facing the industry would severely impact banks' funding costs, deposit composition and the credit quality of their loan portfolios. The regional bank index has bounced back considerably since then, however, increasing close to 16% in July.
Whether the rebound in bank stocks since July is a "melt up or sustainable rally" is yet to be determined, McEvoy said. However, he noted that banks have demonstrated in the months since the liquidity crunch erupted in March that they have many funding options available from the Federal Home Loan Bank system, the brokered CD market or through digital banks like Citizens Financial Group Inc.'s Citizens Access or Equity Bancshares Inc.'s Brilliant Bank. Having multiple levers to pull stands in contrast to some investors who worried during the depth of the liquidity crunch that the industry's liquidity would be fleeting.
"There's a lot of avenues to grow and support your funding base and banks have successfully utilized those funding sources to provide liquidity to fund their day-to-day operations and to fund loan growth," said McEvoy.
Banks' efforts to shore up their balance sheets in the aftermath of the liquidity crunch in March, including from institutions acting out of an abundance of caution, seems to have woken up depositors to higher rates that are available in the marketplace. McEvoy said there is no denying that the events in March and April heightened customers' sensitivity around deposit insurance from the FDIC as well as the rate they received on their deposits. Greater awareness from customers is now translating into higher expectations for deposit betas, or the percentage change in market rates that banks have to pass on to their customers.
"A year ago, if we were having this conversation, we probably would have said deposit betas this cycle land up maybe in the mid-30s range, whereas the outlook for management teams last week on average is in the low 50s. And I should point out that the average cycle-to-date beta so far, at least for the superregional banks that have reported is now already at 41%," the analyst said.
The analyst noted that bankers expect credit to normalize from historically benign levels and for credit costs to steadily rise. Importantly though, bankers do not see a change occurring overnight. He further noted that banks have worked to derisk balance sheets and have built reserves for areas of concern like CRE office loans.
McEvoy said bank stock valuations previously had reflected a very challenging rate environment and higher-than-expected credit losses, but now that bank stocks have rebounded, the analyst believes investors need to be more selective, with superregional banks trading at 10x earnings compared to 8x earnings earlier this year.
"Estimates have come down more than stock prices to the fact that P/Es are 10x earnings and maybe closer to the middle part of their longer-term range, so I think the market is priced in properly," McEvoy said. "But the normalization of credit, should that happen faster than expected, does present a risk at these multiples, again, given the move in stock prices that have occurred, particularly over the last two or three weeks."
